Step 1: Concept
The degree is the power of the highest-order derivative after the equation is cleared of radicals and fractions.
Step 2: Meaning
We need to isolate the square root and square both sides to make the equation polynomial in terms of derivatives.
Step 3: Analysis
$y - x\frac{dy}{dx} = a\sqrt{1 + (\frac{dy}{dx})^2}$. Squaring both sides: $(y - x\frac{dy}{dx})^2 = a^2(1 + (\frac{dy}{dx})^2)$.
Step 4: Conclusion
The highest derivative is $\frac{dy}{dx}$ (order 1), and its highest power in the expanded equation is 2. Therefore, the degree is 2.
Final Answer: (D)